Christian Tegllund Blaabjerg, chief economist at FIH Erhvervsbank, said markets were also inspired by better-than-expected purchasing-managers surveys in the euro-zone and also Germany, which pointed toward ”not-that-bad GDP numbers.”

The Markit Flash Germany Manufacturing PMI index rose to 48.1 in December from 47.9 in November.

That was followed by the Markit flash euro-zone Purchasing Managers Index, which went to 46.9 in December from 46.4 in November.

Markets also embraced upbeat results from a Spanish bond auction, with borrowing costs lower than in prior auctions and with the amount raised almost double what was expected.

“Spain has less outstanding debt than Italy, but probably a worse economy with a massive property bubble yet to cause real havoc to either the banking sector or consumers. However, it seems that the smaller debt pile is what investors are focusing on, for the time being,” said Louise Cooper, market strategist with BGC Partners, in emailed comments.

Shares of Spanish telecom group Telefonica SA (TEF) fell 1% after the company said it will reduce dividends in 2012 and 2013.

Financials in focus

In Frankfurt, shares of Commerzbank AG (CBK) rose 6.7%. The Wall Street Journal reported that the bank is in talks with the German government to transfer part or all of its struggling real-estate unit into a government-owned bad bank. Bailout rumors have persistently followed the bank. A spokesman for Commerzbank declined to comment.

The German DAX 30 index (DAX) added 1% to 5,730.62, with Allianz SE (ALV) up 2.7% and Munich Re AG (MUV2) up 1.9%.

In Paris, the CAC 40 index (PX1) rose 0.8% to 2,998.73, with hotels group Accor SA (AC) up 4.6%.

Shares of Credit Agricole SA (ACA) fell 4.4%. Late in the prior day, Fitch Ratings downgraded the investment-grade ratings on five major European commercial banks by one notch each, including Credit Agricole. In addition, Credit Agricole announced plans to cut 2,350 jobs and shrink its investment-banking activities. It said it will report a loss for 2011.

Sentiment remains tough for Europe’s banks though, said FIH’s Blaabjerg. “U.S. dollar-funding for banks is still horrible. The U.S. is pulling back their investments from Europe and swapping their euros into U.S. dollars, and European banks can’t get U.S. dollar funding despite the recent price cut by the Fed.”

In London, shares of insurer Old Mutual PLC (OML) surged 11.4% on news it will sell its Nordic unit for £2.1 billion ($3.25 billion) in cash to Skandia Liv. The gains helped boost the FTSE 100 index (UKX), which closed up 0.6% at 5,400.85.

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